In the world of investing there is a lot of talk about different sectors. Here we break down what they are and how diversifying your portfolio can make a big difference …
Financial markets categorise company stocks into different sectors. Each sector is a group of company stocks that are in similar industries or have a lot in common with each other. One popular sector categorisation is the Global Industry Classification Standard, known as GICS, which breaks the market down into eleven sectors:
1. Healthcare:
Healthcare is comprised of pharmaceutical and biotechnology treatment development. It also contains healthcare services, equipment, and health insurance companies. Examples: UnitedHealth Group and Pfizer.
2. Materials:
These companies provide the raw and refined materials needed to keep supply chains going such as base metals, chemicals, glass, and construction materials. Examples: DuPont and Heidelberg Cement.
3. Energy:
Typically, oil and gas companies are involved in exploration & production, refining & marketing, as well as companies that provide them equipment and services. Examples: BP plc and Exxon Mobil.
4. Consumer Discretionary:
Companies included in this sector produce consumer goods and provide services that aren’t considered staples of living. It also includes automobiles. Examples: Amazon, BMW and LVMH.
5. Consumer Staples:
This sector makes and sells items people always needs such as food and beverages, personal hygiene, and household cleaning products. Examples: Procter & Gamble, and The Coca-Cola Company.
6. Industrials:
These companies make industrial equipment such as airplanes, electrical equipment or building products, and provide services such as construction and transportation. Some of the largest industrial companies in Europe are Siemens and Airbus.
7. Utilities:
These are typically regulated monopolies such as electricity, gas, and water distribution companies. Renewable energy companies are also in this sector. Examples are the UK’s National Grid and Électricité de France.
8. Financials:
The sector is comprised of banks, insurance, and diversified financials such as payments and investments. Visa, JP Morgan Chase, and Berkshire Hathaway are amongst the biggest in this sector.
9. Information Technology:
This sector is comprised of software, tech hardware and semiconductor companies. This sector includes some of the highest valued companies in the world including Apple and Microsoft.
10. Communication Services:
This is comprised of companies that provide communication services, such as telecom companies, as well as media companies. Examples: Alphabet and Vodafone.
11. Real Estate:
Real estate development and management services and real estate investment trusts (REITS). The largest real estate company in Europe is SEGRO plc, which owns 103 million square feet of warehouses and industrial property.
The Defensive and the Cyclical
Market analysts often talk about “defensive vs cyclical” sectors. What does this jargon mean? And why does it matter?
Cyclicals
“Cyclicals” are the companies that provide goods and services where demand is greatly influenced by the ebbs and flows of the business cycle. In times of recession a cyclical stock will typically go down more than the rest of the market. Investors are then typically drawn to the potentially higher earnings growth and returns from cyclicals during periods of stronger economic growth. While stock and sector classifications, and economic sensitivity change over time, the sectors that are typically considered cyclicals are: Materials, Industrials, Consumer Discretionary, Financial Services, and Information Technology. Energy used to be considered defensive, but we’d argue its more cyclical now.
Defensive
The ‘Defensive’ category is typically made up of Consumer Staples, Healthcare, and Utilities. These are typically companies that make products or services that consumers always need and in about the same amount, even in times of economic slowdown. When times get tough, a portfolio biased to defensive stocks with more consistent and stable earnings should perform well. The sector classifications above aren’t perfect guides to defensiveness; sometimes, even in recessions people keep buying little luxuries.
Diversifying into different sectors
The point of talking about ‘Cyclicals’ and ‘Defensives’ is because certain sectors perform better in different economic climates. If investment portfolios are positioned to anticipate the changes in the economic cycle, then they should perform relatively well, preserving value in difficult times and getting better performance in good times. But it is difficult to predict the future and cycles aren’t exact replicas of the past. Hence, it is important to diversify investment portfolios to reduce overall risk, to prepare for the future rather than trying to predict it too specifically. Adopt a strategy of investing in a variety of sectors and a variety of stocks within sectors. It helps to protect your wealth and achieve more consistent returns in the long term.